Modern monetary policy has the consensus opinion that the ideal inflation target is about 2% annually.

But inflation sucks. No one likes prices going up. Often salaries lag behind the rising prices of consumer goods. It provides opportunities for business to hide price gouging because they’re “just updating prices to reflect inflation” as we saw during inflation. It makes it harder to compare prices historically because the value of money changes with time.

Here’s my best understanding of why a 2% inflation target is a good idea:

  • inflation disincentives saving and incentivizes shorter term spending/investment; savings slowly decrease in value
  • inflation creates a default downward direction of price adjustment, where prices would otherwise tend to be “sticky”
  • inflation benefits debtors, causing their loans to decrease in relative value
    • this decreases the US debt too
  • inflation targets all monetary assets, providing a way to “tax” even cash (i.e. held by foreign countries)

But one of the primary purposes of prices is as a signal. Having the primary measure of value continuously change makes it harder to use. We wouldn’t want the meter, Fahrenheit, etc. to change by 2% every year.

Arguably, the 2% inflation target bakes in 2% expected growth per year. By default everything should go down in price by 2% each year if humanity is collectively growing 2% richer each year. I think that because people are more likely to notice changes in price, than something staying the same price. In practice, because there’s a bias towards prices decreasing each year, there actually are more price increases than decreases which contributes to the sense that things only get more expensive. I think the resulting negative sentiment, ends up being more of an obstacle to progress than the default price adjustment ends up being a benefit.

Practically, I think it’s probably not worth trying to transition away from the 2% inflation target. But, I think it’s theoretically possible to replace a lot of the benefits of inflation with alternate fiscal measures. If I had a magic wand, I’d imagine an independent Fed with a much wider range of fiscal tools:

  • granular control over the rate of a savings / wealth tax: this tax would can be Pigouvian, incentivizing spending/re-investment over saving, leading to the positive effects of increased cash flow. It can also be explicitly made more progressive if desired. The tax could even potentially be negative in the case of debt.
  • ability to grant direct fiscal stimulus: instead of indirectly increasing available money by lowering interest rates, why not hand it out directly
  • economic sanctions are already able to achieve a lot of the goals of controlling what other countries are able to do with US economic assets

There’s one thing that a 0% inflation target would be unambiguously bad for: the US’ massive debt. It wouldn’t really be possible to decrease the interest rate of bonds, if we made such a policy change.

My plan is to write a series of short articles:

  • Inflation makes prices less useful: this is the part of the argument I’m the most invested in.
  • Inflation acts as a wealth tax, and is largely regressive. This is a fairly trodden out argument, but I think I would want to give my own spin on it as part of the series
  • We could give an independent Fed more flexible fiscal controls, and have them target 0% inflation